Conventional Loan

What is a conventional loan?

Mortgages that are not insured by the government are conventional loans, some examples include:

• Conforming loans
• Non-conforming loans
• Jumbo loans
• Portfolio loans
• Sub-prime loans

Some conventional loans will also be called “conforming” mortgages, because they conform to guidelines issued by Governmental Sponsored Enterprises (GSEs), such as Fannie Mae and Freddie Mac. These two GSEs buy mortgages from lenders and sell them to investors.

Other conventional loans are also called “non-conforming” mortgages because these loans are for homes that cost more than the loan limits set by Fannie Mae or Freddie Mac. These mortgages are known as “jumbo” loans.

“Portfolio” loans are also considered conventional loans; they are issued by private mortgage lenders that set their own guidelines. Since these lenders don’t sell mortgages to investors, they can offer unique features that other lenders can’t. For example, a lender may allow a borrower to use stocks, bonds, or other investments as security for a mortgage.

“Sub-prime” mortgages are conventional loans offered to borrowers with low credit scores. Because these borrowers are considered high-risk, lenders can issue higher interest rates and enforce stricter terms.

What are the conventional loan requirements?

If homebuyers decide to finance a conventional loan, there are a few requirements potential borrowers must follow to qualify. For example:

A conventional loan requires borrowers to make a down payment of as little as three percent. Because lenders usually require borrowers to put down 20 percent of the home’s value for a conventional loan, they can issue higher interest rates and stricter terms.

Since lenders allow borrowers to make a down payment under 20 percent, they will require private mortgage insurance (PMI). The premium is an additional monthly fee rolled into the borrower’s monthly mortgage payments. The premium only protects lenders if a borrower defaults on the loan. The way a borrower’s PMI is calculated is based on their credit score. Meaning, the better your credit score, the lower your premiums.

A borrower’s debt-to-income (DTI) ratio is another factor your lender will calculate. Typically, DTI for a conventional loan can be up to 43 percent. However, some lenders may accept higher ratios, but this depends if the borrower has a higher credit score or ample cash reserves. You can calculate your DTI by subtracting your monthly gross income from your recurring monthly debts.

When borrowers apply for a conventional loan, most lenders will require them to have at least three months’ worth of cash reserves after closing. Simply, this means borrowers must have three months’ worth of funds to cover monthly mortgage payments in addition to other home-related costs. This will give lenders reassurance borrowers are financially fit to finance the home beyond the closing day.

Like other mortgage loans, lenders will require to see documentation regarding your income, employment history, assets, and more. For a general scope, here is what they will require:

• Bank statements from last 2-3 months
• 30 days’ worth of pay stubs
• Last 2 years of tax returns
• Last 2 years of W2’s
• Employment history
• Validation of income
• Social security and disability payments (if applicable)
• Dividend earnings, assets, etc.
• Debts

This will give lenders a better idea of the rates and terms they can approve borrowers for.

What are conventional loan requirements?

Conventional loans were designed for those who have an average credit score and are unable to make a down payment of 20 percent. Because lenders allow borrowers to put down as little as three percent, they can issue a higher interest rate due to their credit risk. In addition, require them to purchase private mortgage insurance (PMI) to protect the lender if the borrower defaults.

Depending on the type of home, borrowers will need to have a specific credit score, down payment amount, and at least three months of cash reserves after closing to qualify.

Your lender can evaluate your financial stability and desired loan amount to determine if you are qualified to finance a conventional loan.

What is the difference between a conventional and an FHA loan?

A conventional loan is a type of mortgage that is not insured or guaranteed by the federal government. All this means is that lenders will not be reimbursed for the loan if the borrower stops making payments. Because conventional loans are not guaranteed by the government, lenders can require borrowers to purchase private mortgage insurance (PMI) if they put less than 20 percent down.

Other conventional loans include conforming mortgages. Conforming mortgages must follow guidelines set by Fannie Mae and Freddie Mac. Again, because the government isn’t backing the mortgage for the lender, conventional conforming loans are more difficult to qualify for compared to an FHA mortgage. As a rule of thumb, lenders are more willing to approve borrowers for a conventional conforming loan if they have a good credit score, steady income, and can put down 20 percent.

An FHA loan is a mortgage that is insured by the Federal Housing Administration. This means, if a borrower financing an FHA loan fails to repay it, the FHA will reimburse the lender for their loss. Because an FHA loan is guaranteed, lenders can offer competitive interest rates, terms, and down payment percentages.

Also, borrowers with low credit scores are eligible to qualify, which makes the idea of homeownership achievable. Like a conventional loan, lenders will require FHA borrowers to purchase mortgage insurance if they put down less than 20 percent.

Getting started

Conventional loans come in all shapes and sizes and most lenders can find a way to make one work for you. If you have any questions regarding mortgage programs, please reach out to us. Get pre-approved for financing today by filling out a mortgage application.